Retail Electricity Prices: It’s Time to Unbundle the Package

With the growth of the distributed solar PV market, there’s been quite a lot of attention paid to the fate of electric utilities recently, ranging from environmental news website Grist to the electricity industry’s Edison Electric Institute.

We recently outlined many of the challenges and a few key approaches that RMI is taking to create real solutions in “The Calm Before the Solar Storm.” Those approaches include the work of the Electricity Innovation Lab (e-Lab), whose efforts include a focus on the need to realign electricity pricing structures. Simply put, prices need to provide more accurate signals that reflect the actual costs and values in the electricity system.

In the electricity sector, behind-the-scenes pricing structures translate into the upfront electric rates that a utility offers to its customers and, through which, recovers its costs. While there are myriad variations on the theme around the country, the predominant pricing structure for residential and small business customers is a bundled, volumetric charge. In other words, a customer pays a single, average rate multiplied against the number of kWh consumed.

That means that a utility assesses all its unique costs—ranging from maintaining a large, coal-burning power plant to a transformer station down the street—bundles those into a total, and then allocates those costs to different customer groups. Often, residential and small businesses see these costs allocated to them as a dollar per kilowatt-hour rate. An important aspect of such an approach is that all costs, whether fixed or variable, are allocated through a volumetric price. The more electricity you use, the more you pay.

One Size Doesn’t Fit All

Historically, this one-size-fits-all pricing structure has worked well—it served to adequately compensate the utility, it’s simple, and because most or all of the utility’s costs are charged to customers per kilowatt-hour, it provides an incentive to customers to do energy efficiency. But, as we described in New Business Models for the Distribution Edge, with increasingly high penetrations of distributed and renewable resources, volumetric, bundled prices are fast becoming inadequate. In such a system, the current structure will not appropriately compensate the utility for its service, and customers will not have the right incentives to invest in technologies that can benefit both them and the system as a whole.

We need rational pricing structures that more accurately reflect the costs and values. Doing that likely requires some degree of price unbundling—charging separately for different cost components. While volumetric, bundled prices are not yet problematic in many parts of the country, it is critical to proactively begin to assess, test, and implement new solutions now. Doing so can ease brewing conflict and pave the way to a more seamless integration of significant levels of solar and other distributed resources.

Many possible models for unbundling and/or more accurately reflecting the costs and values of distributed energy resources have been proposed, ranging from time-of-use pricing to standby charges to a value of solar tariff. But at the end of the day, how do we make sense of the options, and what’s a viable pricing structure that balances the needs for both accuracy and simplicity?

Unbundling the Price Package

We had an important opportunity to explore this question as part of our third e-Lab meeting, held May 6–8 in Austin, Texas. In an intensive working session, we asked a diverse sub-group of e-Lab participants—including representatives from utilities, regulatory bodies, and solar companies—to wrestle with this issue, make recommendations for what characteristics new pricing models should have, and identify how e-Lab can best move this work forward. While we can’t claim to have solved the problem (yet), some key insights emerged that help inform a path toward effective, new pricing structures.

The goal of any new pricing structure should be to ensure that customers pay fairly for what they use and receive fair payment for what they provide. So, for example, if a customer has rooftop solar but still uses the grid for nighttime power, the customer should pay for that service. And on the flip side, if that rooftop solar provides capacity or other services to the grid, the customer should likewise be paid for that.

There are four overarching steps to effective price unbundling:

Separate what is used from what is provided. By separately measuring and then netting out on the customer’s bill, costs and values can be more accurately reflected. This structure could potentially overcome an unintended consequence of today’s net metering programs—that some customers view solar as “free” energy and therefore have less incentive to conserve it.

Within those used vs. provided buckets, disaggregate cost/value components to some degree. It is likely not necessary—nor a good idea—to unbundle every individual cost or value component. Key cost and benefit components might include the effects on: energy + line losses; generation, transmission, and distribution capacity; ancillary services; customer service costs; the costs of any policies or programs the utility is responsible for implementing; fuel costs; and environmental impacts. Other values such as carbon reduction, health benefits, or jobs could be reflected as part of an added incentive.

Determine the appropriate recovery mechanism for disaggregated components. Some utility costs of service may be fixed and others variable. Fixed costs could include unavoidable operations and maintenance for infrastructure, investment costs, and employee payroll, whereas variable costs are those that vary with the amount of electricity produced, including fuel expenses and purchased power. Regardless of the source of cost, there is a separate decision around whether those components are then presented to the customer through a fixed or variable charge. As an example, consider historical residential rates. In this case, a utility’s fixed costs are rolled into a price per kWh. The utility’s actual cost and the customer’s per unit price are fixed, but the amount the customer pays depends on the amount of electricity consumed, hence variable. Part of that discussion necessarily involves an assessment of what behavioral signals the utility is trying to send and what the best way to do that is.

If appropriate, add an incentive to recognize additional value not captured in utility pricing. This incentive could be designed to ratchet down over time, similar to the California Solar Initiative’s sliding incentive scale based on the amount of generation capacity installed, to reflect the continued falling costs of solar technology.

Some values are near term and others are long term. It’s important to know and recognize the difference so that long-term value is paid for and so that those long-term impacts can be effectively built into system planning. For example, does well-sited distributed solar offset the need for distribution or other capacity expansion upgrades?

The Price (and the Time) is Right

Pricing is a critical topic and the confluence of declining distributed resource costs, increasing adoption, and increasing industry attention on the topic mean that the time is right.

Going forward, e-Lab is working on the issue in several ways. Later this month, we will release a comprehensive review of major studies conducted to date that evaluate the costs and benefits of distributed solar photovoltaics. Conducted as part of e-Lab’s emPower project and RMI’s DOE-funded Innovative Solar Business Models project, the review is a first step to move beyond rhetoric and start to consider the data as the pathway for building a solid foundation from which more effective pricing structures and business models can be created.

Over the next few months, we will continue to drive towards clarity on what good pricing structures look like and further develop a hypothesis or strawman. We will also be coordinating with industry experts and stakeholders, especially those running pilot projects and gathering real data, to learn and to refine that pricing structure. Finally, we will seek to work directly with one or more utilities to adapt our strawman, test it, and ultimately implement it.